Common Accounting Mistakes: Government Edition - Issue #1: Am I Accrual or Cash Basis?

One of the most common errors made by executives in a small startup is assuming that the reporting basis for accurate financial statements can be changed by clicking the single button at the top of the QuickBooks report.   It seems simple, but in reality entails much more. 

Most small businesses choose to keep their books on cash basis.  This is the simplest form as your books match your bank account.  The accrual basis of accounting matches income and expenses in the same time frame, regardless of when the money came into or left the bank account. If the information entered into QuickBooks doesn’t accurately provide all the data needed to determine the timing, the accrual reports will not be accurate. Additionally, accrual accounting often requires manual journal entries to properly account for depreciation, payroll and vacation accrual, prepaid expenses, and several others. 

For example: Doe Co. did work for a customer and sent them an invoice on 6/25/2020.  They did not receive payment for the invoice until 7/3/2020.  Using cash basis accounting, Doe Co. shows all the expenses for the work done in June, but none of the revenue.   Using accrual basis accounting the income would show in June even though the payment had not been received yet.  This would match the income and expenses for the job so you could see how much profit was made.

If you are submitting proposals for a government contract, the government prefers the accrual basis of accounting because it gives a more accurate picture of the company’s profit or loss.  While this is only a preference, a reconciliation of cash basis vs accrual basis is required at the end of the fiscal year if a company chooses to report using the cash basis.  The issue is that auditors don’t arrive only after the fiscal year has been closed.  If a company is audited in the middle of the year, a panic ensues to get the books in order and reconciled to an accrual basis.